Tuesday, June 14, 2016

Mattress Fire

 Back in May—that’s less than two months ago—the Chief Marketing Officer of Mattress Firm (ticker: MFRM; Tangible Book Value Negative $30.32 Per Share if our Bloomberg is correct)—was asked how business had started the new year.
  “It continues to be a bit choppy…” he began—choppy being one of those euphemisms Wall Street hates to hear—before adding, in the true nature of a marketing guy, “…but we’re SUPER optimistic that we’re coming up on summer selling season, Memorial Day...”
 Sure enough, Memorial Day did come—even if Mattress Firm appeared to begin the Memorial Day sales event a week or two before the actual weekend—giving the CEO something positive to talk about on the ensuing earnings call, when some of the more important numbers were otherwise going the wrong way.
 Specifically, while MFRM showed 49% revenue growth in the first quarter, it was thanks mainly to the acquisition of Sleepy’s and other mattress retailers the previous twelve months.   What analysts call “organic” growth was somewhat less than 49%.  
 Like, 5,000 basis points less.
 Comp-store sales were down 1.1% in the quarter (despite a boost from the inclusion of e-commerce sales from the recently acquired 1,000-store Sleepy’s chain in those “comp-store sales,” for some weird reason).
 For a clearer picture of the sales trend at what management itself likes to call “the first truly border-to-border, coast-to-coast multi-brand mattress retailer,” it’s worth noting that comp-store transactions—i.e. stripping out the effect of sales mix—were down 0.9%.
 That decline in comp-store transactions at MFRM was not, however, a new phenomenon: MFRM has reported declining comp-store units in each of the last five quarters (except for one that was termed “roughly flat”).
 The seemingly innocuous 0.9% comp-unit decline in the most recent quarter looks a little less innocuous when you consider it was up against a seemingly easy-to-beat 6.4% unit decline in the same quarter last year.
 As usual with MFRM, however, things got better after the quarter ended, according to management on the call: “Since Memorial Day our trends have been positive and in line with our revised same-store sales guidance,” they said.
 We’ve heard that kind of “things got better this week” from companies reporting otherwise dour news many times…in fact, we heard it from MFRM last year, when it reported that negative 6.4% unit comp quarter: “However, late in the quarter we implemented certain initiatives to drive units and we had subsequently seen positive results.”
 Prosperity at Mattress Firm is always just around the corner.
 Unfortunately, just around that corner is a new competitor: the internet.
 Specifically, what are termed “Bed-in-a-Box” competitors (Tuft & Needle, Casper et al) that sell mattresses rolled up in boxes delivered straight to your door by UPS and therefore have no need for 3,500 stores like MFRM, or commissioned sales employees or delivery trucks.
 Indeed, according to figures disclosed at a Furniture Today conference in May, the “Bed-in-a-Box” industry—and full disclosure, your editor is a happy repeat Casper customer—is running at a $900 million sales rate right now, from a standing start 4 years ago.
 While $900 million might not sound like much in an industry reported to be worth $7 billion in total (mattresses, not all bedding-related products), it would be the equivalent of about 700 Mattress Firm stores by our math, or about 20% of those “boarder-to-boarder, coast-to-coast” stores.
 Is it any wonder MFRM comp-store transactions have been flat-lining lately?
 And while MFRM would probably note that many of the bed-in-a-box vendors are establishing show-rooms in major cities like Manhattan, we’d bet money that they won’t open anything close to 3,500 stores when it’s all over. 
 Why bother?  They’re already “boarder-to-boarder, coast-to-coast” mattress retailers, in the sense that they can ship anywhere a UPS truck can go, without the fixed cost structure.
 All this makes last night’s news that MFRM had disclosed a “material weakness” in its just-filed 10Q involving “controls relating to accounting for significant transactions” even more interesting than the usual “material weakness” disclosure in your average 10Q:
"Specifically, we did not design and maintain effective controls related to the recording of the expense for the flow through of the inventory step up fair value adjustment in the Sleepy's acquisition. We believe the financial statements included herein properly reflect the correct amount and proper classification of the flow through of the Sleepy's inventory step-up adjustment….”
 You might think that a company with $1.1 million of cash and $1.6 billion of total intangible assets on its balance sheet (thanks to its “coast-to-coast” rollup of mattress retailers) against $1.45 billion of debt, negative $55.4 million of retained earnings and $477.4 million of total shareholder equity would have been on those issues before they cropped up, but apparently not.
 Meanwhile, and unfortunately for MFRM, the Caspers of the world are not sitting still, and watching a reported $900 million worth of mattresses get siphoned off to direct-to-consumer competitors is exactly the thing Mattress Firm doesn’t need at this moment.
 The company spent years steadily snapping up new geographies as part of its grand plan—Mattress Giant, Sleep Experts, Mattress Liquidators, Best Mattress, Sleep Train and, finally, Sleepy’s—at the very moment clever Millennials were figuring out how to design, manufacture and ship a mattress in a box so that they and their friends didn’t have to deal with the process of schlepping down to one of those stores Mattress Firm has been accumulating.
 So when we hear the word “choppy” to describe the sales environment—as we did in May from MFRM’s own marketing man—our ears perk up.  
 “Choppy” is one of those Wall Street euphemisms that can often mean a whole lot more than it looks on paper.  
 It’s right up there with analysts who are “tweaking our estimates lower” (i.e. slashing them) and sales that have “come in a bit light” (i.e. not even close to plan).
 Or, our favorite, management that is “laser-focused” on the company’s problems (i.e. playing solitaire on their iPhones).
  Unfortunately for MFRM, “material weakness” is not a euphemism. 

Jeff Matthews
I Am Not Making This Up

© 2016 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.

4 comments:

Redeye Malone said...

Hi Jeff, I saw this linked on abnormal returns. I loved this post. I've been reading alot of conference calls recently and it's so difficult to tell if management is shooting straight or painting over the ugly. With alot of depressed retailers I've heard that "things are picking up in recent weeks" comment so many times and its so hard to tell if it's real or not.

One thing's for sure: In bulk, there's more confidence than seems justified. I want so badly to think management is giving a fair assessment of the business on the calls, but I can't tell if going through the effort of reading them all is worth it. Should i just read the 10K/10Q and leave it at that?

Appreciate any insight on the best way to deal with this. I feel like reading the conference call should help me understand what's happening in the business, but I also worry that it's often misleading me.

Jeff Matthews said...

It's about pattern recognition and over the course of several calls you learn who's for real and who's making it up. Also, listen to some great companies even if you don't own the stocks, so you have a base-line of what honest guys sound like. But don't forget the K's and Q's. Thanks.

John Hempton said...

Not my day. I was short a slither.

The takeout is truly amazing. Breathtaking really.

J

Jeff Matthews said...

Turns out prosperity was, in fact, just around the corner for MFRM shareholders. Shades of Gerald Ratner buying Kay Jewelers circa 1990, just because he could.